A COMPARATIVE STUDY ON THE PROFITABILITY PERFORMANCE OF COMMERCIAL BANKS IN ETHIOPIA

A COMPARATIVE STUDY ON THE PROFITABILITY PERFORMANCE OF COMMERCIAL BANKS IN ETHIOPIA

Final draft (Report) submitted for the “Fifth International Conference” – Ethiopian Economic Association - Addis Ababa, Ethiopia.

Mr.R.DHANUSKODI*

Mr.R.THANGAVELU♪

Dr.A.VENKATACHALAM#

Dr.S.SUDALAIMUTHU√

[*R.Dhanuskodi, Lecturer, Department of Accounting, Faculty of Business And Economics, Jimma University, Post Box 378, Jimma, Ethiopia. Email ID: d_kodiudt@yahoo.co.in and dhanus_jothi@fastermail.com]

[♪ Mr.R.Thangavelu , Assistant Professor, Department of Accounting, Faculty of Business and Economics, Jimma University, Post Box 378, Jimma, Ethiopia]

[# Dr.A.Venkatachalam, Professor, Department of Commerce (PG), GTN Arts College, Dindigul, India]

[√ Dr.S.Sudalaimuthu, Lecturer, Department of Commerce, Bharathiar University, Coimbatore, India]

15^th February 2007

ABSTRACT

Commercial Banks are the backbone of the economy of the country. It is the determinant factor to bring the development of the country; it serves as a bridge in between savings and investments. Commercial Banks are the institutions specifically designed to further the capital formation process through the attraction of deposits and extension of credit.

The present research titled as “A comparative study on the Profitability performance of Commercial Banks in Ethiopia” The sample of this study contains two public sector banks (CBE and CBB) and six private sector banks (BOA, AIB, DB, UB, WB and NIB). The co-operative Bank of Oromia (CBO) and Development Bank (DB) are not taken in this analysis, for the reason CBO is newly established bank and has not published annual report, the Development Bank involved only specialized activities.

The purpose of the study is to analyze the comparative profitability performance of Ethiopia commercial banks for the financial periods 2000 – 2004. In additions to examine the relationship among banks equity, assets and deposit size to profitability. The banks are ranked based on their growth percentage (Equity, Asset, and Deposit) and profitability performance (ROE, ROA and ROD)

The objectives of the study are; to assess the commercial banks equity, asset and deposit sizes, growth percentage and average. To analyze the profitability performance of commercial banks by using ROE, ROA and ROD ratios and to make ranking the commercial banks on the basis of growth percentage and profitability ratios.

The present study is divided in to five chapters; the first chapter gives a bird’s eye view of commercial bank, the concepts of performance and profitability, ROE, ROA and ROD, banking industry in Ethiopia, and branch net work of the banking system. It also includes a brief description about the purpose of the study and objectives of the study. The second chapter deals with review of related studies. The third chapter devoted for methodology. The fourth chapter gives results and analysis, which includes comparison of banks equity, asset, and deposits, ROE, ROA and ROD. The fifth chapter contains the summary of findings and conclusion.

TABLE OF CONTENT

Sl.No	Chapter No.	Content	Page No
1		Abstract	2
2		Table of content	3
3		List of Tables	4
4		List of chart	4
5		List of Abbreviations	4
6	I	INTRODUCTION 1.1 Performance and Profitability 1.1.1 Return on Equity 1.1.2 Return on Assets 1.1.3 Return on Deposit 1.2 Banking Industry in Ethiopia 1.2.1 Branch net work of the Banking system 1.3 Purpose of the Study 1.4 Objectives of the Study	5
7	II	LITERATURE REVIEW	9
8	III	METHODOLOGY	12
9	IV	RESULT AND ANALYSIS 4.1 Comparison of Banks Equity 4.2 Comparison of Banks Assets 4.3 Comparison of Banks Deposits 4.4 Comparison of Banks ROE 4.5 Comparison of Banks ROA 4.6 Comparison of Banks ROD 4.7 Rank of Commercial Banks in Ethiopia based on Growth percentages (Equity, Asset and Deposits) and Profitability indicators (ROE, ROA and ROD)	17
10	V	SUMMARY OF FINDINGS AND CONCLUSION	17
11		REFERENCES	18
12		APPENDIX Branch net work of the banking system	19

LIST OF TABLE

Sl.No.	Table No.	Content	Page No.
1	4.1	Comparison of Banks Equity	13
2	4.2	Comparison of Banks Assets	13
3	4.3	Comparison of Bank Deposits	14
4	4.4	Comparison of Banks ROE	14
5	4.5	Comparison of Banks ROA	15
6	4.6	Comparison of Banks ROD	15
7	4.7	Rank of Commercial Banks in Ethiopia based on Growth percentages (Equity, Asset and Deposits) and Profitability indicators (ROE, ROA and ROD)	16

LIST OF CHART

Sl.No.

Chart No

Content

Page No.

1.1

Banks in Ethiopia

LIST OF ABBREVIATIONS

Sl.No	Abbreviations	Expansion
1	ROE	RETURN ON EQUITY
2	ROA	RETURN ON ASSET
3	ROD	RETURN ON DEPOSIT
4	CBE	COMMERCIAL BANK OF ETHIOPIA
5	CBB	CONSTRUCTION &BUSINESS BANK
6	DBE	DEVELOPMENT BANK OF ETHIOPIA
7	AIB	AWASH INTERNATIONAL BANK
8	DB	DASHEN BANK
9	BOA	BANK OF ABYSSINIA
10	WB	WEGAGEN BANK
11	UB	UNITED BANK
12	NIB	NIB INTERNATIONAL BANK
13	CBO	CO-OPERATIVE BANK OF OROMIYA

A COMPARATIVE STUDY ON PROFITABILITY PERFORMANCE OF COMMERCIAL BANKS IN ETHIOPIA

I. INTRODUCTION:

Banks are key financial intermediaries or institutions that serve as “middle man” in the transfer of fund from servers to those who invest in real assets as house, equipment and factories. In performing this function financial intermediaries improve the well being of both saver and investor. By improving economic efficiency they raise living standard of the society.1The banking sector is considered to be an important source of financing for most businesses.2 Commercial banks are the backbone of the economy of the country. It is the determinant factor to bring the development of the country. It serves as a bridge in between savings and investments3.

Commercial banks play a very important role in the effort to attain stable prices, high level of employment and sound economic growth. They make funds available to meet the needs of individuals, businesses and the government. In doing this, they facilitate the flow of goods and services and the activities of governments. The commercial Banking system provides a large portion of the medium of exchange of a given country, and is the primary instrument through which Monitory policy is conducted, through their deposit mobilization and lending operations. Commercial banks make the productive utilization of ideal funds, thus assists the society to produce wealth4.

1.1 Performance and Profitability:

Performance, as defined by Lusser (1996) is means of evaluating how effectively and efficiently organizations use resources to achieve objectives. The performance of commercial banks is judged by many factors. For the sustainability of commercial banks, profitability very significant factor and that can be used to measure the performance of commercial banks.

Return on Equity (ROE), Return on Assets (ROA) and Return on Deposits (ROD) are generally considered profitability measures.

1.1.1 Return on Equity (ROE):

This ratio establishes a relationship between Net income and Average totals equity. The ROE is calculated by dividing net income by average total equity.

Net Income

ROE = ------------------------ X 100

Average total Equity

Net income is calculated by deducting total operating expenses and taken from the taxes from the total revenue. The total revenue is equals the sum of interest income, non-interest income and securities gains. Total operating expenses equal the sum of interest expense, non-interest expense, and provision for loan and lease losses. Equity is the sum of share capital, preference shares, paid in surplus, retained earnings and revenues for future contingencies. The higher the return the better, as banks can add more to retained earnings and pay more in cash dividends when profit are higher. ROE indicates the rate of return on equity capital and is particularly significant in the context of objective of maximization of share value.

1.1.2 Return on Assets (ROA):

ROA measures the ability of management to utilize the real and financial resources of the bank to generate income and is used to evaluate management. ROA equals net income divided to average total assets.

Net income

ROA = -------------- X 100

Total Assets

ROA refers the bank management ability to generate profits by using the available financial and real assets.

1.1.3 Return on Deposit (ROD):

This ratio indicates the profitability performance of the bank. It is calculated by dividing the net income by total deposits.

Net income

ROD = ----------------- X 100

Total Deposits

This ratio reflects the bank management ability to utilize the customers’ deposits in order to generate profits.

1.2 BANKING INDUSTRY IN ETHIOPIA:

Banking sector is not a new one in Ethiopia, as in most other countries in the world. The Ethiopian banking system currently comprises a Central Bank, three public sector banks and seven private sector banks.

The National Bank of Ethiopia is a central bank performs the usual central bank functions, services as issuer of bank notes and coins. Bankers to the banking sector and the government controller of the money supply, supervisory of banking operations and administrator of foreign capital, the central bank’s board, which supervises the banks operation, management and administration, formulates major monetary and banking policies. It is responsible for the supervision and regulation of all commercial banks.

The Commercial Bank of Ethiopia took over the commercial banking activities of the former Bank of Ethiopia by 1963. It began its operation on January 1, 1964 with a paid up capital of Birr 20 Million and served for about 16 years. The bank is wholly owned by the state and operated as out of risk institution under the Commercial Code of Ethiopia. It dominates the market in terms of percent of assets, deposits, bank branches, total banking force although all other private banks and paying an active role in the nations financial market.

There are other two government owned specialized banks in Ethiopia the Development Bank of Ethiopia and Construction and Business Bank. Development Bank has also been established Regulation No. 200/1994. The Bank took over the rights and obligation of the Agricultural and Industrial Development Bank of which was established under proclamation No. 158/1979. The Bank objective include mobilizing funds from sources within and outside the country and providing medium and long term investment credits, holding savings, demand and time deposits, acting as treasury and other activities usually performed by Development banks.

The Construction and Business Bank has also been established under Proclamation No. 203/1994 by taking over the rights and obligations of the Housing and Savings Bank which was established under proclamation No. 60/1975.The Banks objectives include proving loans for construction , repair, modification and acquisition of dwelling houses and buildings , for construction sector activities and for the development of hotels and tourism , accepting savings, demand and time deposits, administrating funds entrusted to it by the government or other institutions and carrying out all other activities as are customarily done by banks.

After the implementation of licensing and Supervising Banking Business proclamation No.88/1994, the private people are allowed to start new private banks in Ethiopia. The details of Ethiopia Banks are given in the Chart 1.1

Chart 1.1

Banks in Ethiopia

BANKS IN ETHIOPIA

CBE AIB

CBB BOA

DBE WB

NIB

CBO

1.2.1 Branch network of the Banking system:

At the end of 2004 -2005, the number of bank branches increased by thirty one to reach 389 branches, of which 174 (or about 44.7 percent) belonged to the Commercial Bank of Ethiopia, which is the largest public bank in the country. Despite such a move in branch expansion remains one of the under banked economies even at Sub –Saharan African countries standard. The bank branch to population ratio for Ethiopia stood at 1: 185,000 in 2004 – 2005 compared to 1: 227,797 in 2001 – 2002. (Annexure- I)

1.3 PURPOSE OF THE STUDY:

The purpose of the study is to analyze the comparative profitability performance of Ethiopia commercial banks for the financial periods 2000 – 2004. In additions to examine the relationship among banks equity, assets and deposit size to profitability such as ROE, ROA and ROD. The banks are ranked based on their profitability performance and growth percentage.

1.4 OBJECTIVES OF THE STUDY:

The following are the objectives of the study;

To assess the commercial banks equity, asset and deposit sizes, growth and average.
To analyze the profitability performance of commercial banks by using ROE, ROA and ROD ratios.
To make ranking the commercial banks on the basis of profitability and growth percentage

II. LITERATURE REVIEW:

Performance as defined by Robert N. Lussier (1996) is means of evaluating how effectively and efficiently organizations use resources to achieve objectives. Shelagh Hefternan (1996,P.91) insisted , was that the banking world is changing rapidly, the strategic priority has shifted away from growth and size alone towards a greater emphasis on profitability, performance and value creation within the banking firm. The performance of the banks decides the economy of nation. If the banks perform successfully, the economy of nation must be sound, growing and sustainable one. The performance of macro economy of a country has got a direct and an immediate impact on banks, may be, more than any thing else in the economy, the concepts supported by Greuning and Bratanovic (2000, P.19) from their words, unstable macro economic environment is a principle cause of instability in the financial system.

David Cole (1972) introduced a procedure for evaluating bank performance via ratio analysis. Timothy ,W.Koach and S.Scott Macdonald (2003,P.112) insisted, the aggregate bank profitability is measured and compared in terms of return on equity (ROE) and return on assets (ROA). Return on assets (ROA) is the ratio of earnings to total assets and Return on Equity (ROE) in the ratio of earnings to total equity. The Banker (July) has published data on the world’s largest banks since 1969.It ranked the world’s ;largest 300 banks from 1969 to 1979, the world’s largest 500 banks from 1980 to 1988 and the world’s largest 1000 banks from 1989.Currently, the annual ranking appear in the July issue. The current ranking in based on “strength”, measured by “tier one”, capital, defined as common stock, declared reserves, and perpetual, irredeemable and non-cumulative preference shares, expressed in US dollars. Since July 1991, The Banker reports three other measures of Bank performance: profit on capital (%), return on assets, and on F.T composite credit rating: compiled by The Financial Times news letters using 12 international ratings. An arithmetical average of numerical scores is given to each agency’s investment grade ratings. The highest score is 10, the lowest is 1, prior to 1991, and The Banker reported real profits growth and profits on capital as measures of performance. It indicated, there is virtually no correlation between asset size and profitability.

Birritu (2006, P.7) magazine indicates, the performance of bank in terms of balance sheet structure/trend, earnings and liquidity. David Cates (1996) suggest that one way to circumvent the on versus off balance sheet comparison problem is to calculate performance measures using total operating revenue as the denominator rather than assets. Kaplan and Norton (1992) introduced the concept of the balanced score card, many banks have recognized the importance of developing performance measures that look beyond just financial measures. Timothy, W.Koach and S.Scott Macdonald (2003, P.140) has some interesting aspects in their bank. They mentioned that the Federal and State Regulatory regularly assess the financial condition of each bank and specific risk faced via on site examinations and periodic reports. Federal regulators rate banks according to the ‘Uniform Financial Institutions Rating system, which now encompass six general categories of performance under the label CAMELS. Each letters refers to a specific category including C= Capital adequacy; A= Asset quality; M= Management quality; E= Earnings; L= Liquidity; S= Sensitivity to make risk.

Business India (2004,P.73-90) magazine analyzed and ranked the banks in India under the title of “Best Bank 2004”, on the basis of its financial statements for the year 2003-04.The analysis has taken 27 public sector banks, 16 private banks, and 27 foreign banks. It analyzed all the banks in six different headings, it includes Capital adequacy, and Resource deployed, Asset quality, Efficiency, Earning quality and Liquidity. The each heading includes different ratios. Capital adequacy includes debt-equity ratio, government securities to investments and government securities to asset. The resource deployed contains liquid assets, investments, advances, fixed assets, and other assets ratio. The third category, Asset quality consists of advances to assets, advances to growth, advances yield and investment to assets. The efficiency or management heading comprises Credit-deposit ratio, return on net worth and employee efficiency ratio. Earning quality of Banks is ranked by net profit growth, spread, other income to interest income and net profit to – total average assets. The last category of Liquidity covers liquid asset to total asset and approved securities to total assets.

African Business (2004) had taken 50 Sub-Saharan African Banks and it analyzed and ranked on the basis of tier 1 capital, as defined by the Basel –based bank for international Settlements (BIS). As per this ranking CBE with its core capital of $16 million on June 30,2003 commanded the 13^th place proceeded by 6 South African , 2 Mauritius, 2 Nigerian and 2 Zimbabwean banks.

Almeyehu Geda (1999, P. 28-30) analyzed the performance of Ethiopia’s Financial system in the pre/post return period ; he explained that, the pre-reform period here refer to the period 1974-1991, which he noted as the Derge regime before. During this period all private banks were nationalized. The national bank of Ethiopia (NBE) was at the apex of the banking structure and was engaged in all the functions of a Central Bank. One big Commercial Bank (CBE) and two specialized banks; Agricultural and Industrial development Bank (AIDB) (now renamed Development Bank of Ethiopia) (DBE). Housing and Saving Bank (HSB) [Renamed the Construction and Business Bank (CBB)] was also established.

He further stated that, the deposit mobilized by CBE has been on the average 83% in the pre-reform periods and picked up to 94% in the post reform period. In the pre-reform period the average outstanding loans of the CBE was the highest in the import sector (20%) followed by the export (17%), industrial (15.7%) and domestic trade (14%) sectors. In the post reform period the outstanding loan with domestic trade sector grew enormously (reaching the average more than 35%).This is followed by imports (17.4%) exports (14.2%) and the industrial (11.8) sectors. Despite the expansion of the construction sector in the post reform period, outstanding loan with this sector has shown a market decline from 15% to nearly 4% on the average. In term of institutional disaggregating, loan collection from the private sector was significant which constitutes nearly 40% in the pre reform period and jumped to an average figure nearly 65% in the post reform period. Loan collection from the public sector had been falling steadily in the pre-reform period. This trend has also continued in the post reform period.

The researcher Habtamu Berhanu (2004) had taken the Commercial Banks in Ethiopia for financial performance analysis. The banks include both public sector and private sector banks. The periods of the research starts from 1991-92 (for CBE) and from 1996-97 (for the rest) to 2000-2001.The research showed that the ROEs of BOA, CBE, DB and AIB have gone at 3.21, 1.8, 1.31 and -0.68 percentages respectively. When the ROEs of CBE are observed individually, it is said that ROEs of the years before the entrance of the private banks (1996-97) were better than the ROEs there after. In the analysis, it is said that the bank has managed the expense better before 1996-97.The possible reasons for the decline in the amount of the ROEs are stated as the increase in the provision for loan loss (62.3% in 1996-97, 100% in 1998-99) and increase in capital and reserve account balance. The researcher further disclosed that the decline in the ROAs of CBE is explained as to be the effect of the increase in the total asset. Finally, the research concluded that the private banks performed better than CBE in terms of the profitability ratios.

Messeret (2006) had conducted the research titled as the financial performance of Ethiopian Commercial Banks; he had taken two public sector Commercial banks (CBE and CBB) and six private banks for the research purpose. He calculated the average performance ratios of the private banks for each year and compared with the average. And attempted to form a peer group and developed the average from the peer, then the average figure compared with the banks in the peer group. In additions to that, the trend analysis applied for measuring the performance of banks. The research showed that, four of eight banks have got a positive growth rate in their ROEs while the rest four have experienced a negative growth rate. Those banks that have got a positive growth rate are NIB, WB, DB and CBE ranking in that same order from 1 to 4. The banks that have got adverse growth rates in their ROEs are, BOA , UB share company , CBB and AIB ranking from 5^th to 8^th in that same order.

The research indicates that the averaging out of the changes in the ROEs , CBE ,DB , NIB , WB, and BOA have got a positive growth rates ranking from 1 to 5^th in same order. The rest three, UB Share Company, CBB and AIB, ranking from 6^th to 8^th respectively have experienced a negative growth rate.

The research finally concluded that the two government banks, CBE and CBB are following form behind occupying the 7^th and 8^th positions respectively in all the four aspects (annual growth, rate of asset, loan and advances, deposits and capital) of aggregate item growth rates. Their loan and advance average annual growth rate is negative.

III METHODOLOGY:

The present study is based on the secondary sources of information